World stock markets declined on Tuesday on renewed fears about the health of the US, the world's largest economy.

Wall Street saw its worst share losses in almost a year, after data showed that activity in the key US service sector unexpectedly shrunk in January.

Fears that the worst US housing slump in 25 years is crippling the wider economy sent the Dow Jones index down almost 3% and hit European shares.

The UK's FTSE 100 fell 2.6% on fears of contagion from the US slowdown.

The US benchmark Dow Jones average fell 370 points, or 2.9%, to end at 12,265.1 in New York.

The tech-heavy Nasdaq index slid 73.3 points, or 3%, to 2,309.6 and the broader S&P 500 index also fell 3% to settle at 1,336.7.

Broad sell-off

The Institute of Supply Management's index of business activity in the non-manufacturing sector slid below 50 - a level that indicates contraction.

The index fell to 41.9 from a 54.4 reading in December, the lowest reading since October 2001 and the first time business activity has shrunk in the US service industry in almost five years.

Economists had forecast a milder decrease to 53.0.

"The report drives a nail into the coffin from investors' minds that we're in a recession," said Todd Salamone, director of trading at Schaeffer's Investment Research.

"That doesn't mean stock prices in the months ahead will be lower. But when you see headline numbers like this, there tends to be a reactionary sell."

Analysts said traders were also spooked by fresh threats to the high quality credit ratings of bond insurers, which guarantee billions of dollars in investments linked to US sub-prime loans taken out by banks.

A reduction in their credit ranking would lead to banks, already reeling from losses centred on US mortgages taken out by individuals on low incomes or with poor credit, having to make further write-downs.